As the importance of intellectual capital grows, privilege has become increasingly heritable

Jan 24th 2015

WHEN the candidates for the Republican presidential nomination line up on stage for their first debate in August, there may be three contenders whose fathers also ran for president. Whoever wins may face the wife of a former president next year. It is odd that a country founded on the principle of hostility to inherited status should be so tolerant of dynasties. Because America never had kings or lords, it sometimes seems less inclined to worry about signs that its elite is calcifying.Thomas Jefferson drew a distinction between a natural aristocracy of the virtuous and talented, which was a blessing to a nation, and an artificial aristocracy founded on wealth and birth, which would slowly strangle it. Jefferson himself was a hybrid of these two types—a brilliant lawyer who inherited 11,000 acres and 135 slaves from his father-in-law—but the distinction proved durable. When the robber barons accumulated fortunes that made European princes envious, the combination of their own philanthropy, their children’s extravagance and federal trust-busting meant that Americans never discovered what it would be like to live in a country where the elite could reliably reproduce themselves.

Now they are beginning to find out, because today’s rich increasingly pass on to their children an asset that cannot be frittered away in a few nights at a casino. It is far more useful than wealth, and invulnerable to inheritance tax. It is brains.

Matches made in New Haven

Intellectual capital drives the knowledge economy, so those who have lots of it get a fat slice of the pie. And it is increasingly heritable. Far more than in previous generations, clever, successful men marry clever, successful women. Such “assortative mating” increases inequality by 25%, by one estimate, since two-degree households typically enjoy two large incomes. Power couples conceive bright children and bring them up in stable homes—only 9% of college-educated mothers who give birth each year are unmarried, compared with 61% of high-school dropouts. They stimulate them relentlessly: children of professionals hear 32m more words by the age of four than those of parents on welfare. They move to pricey neighbourhoods with good schools, spend a packet on flute lessons and pull strings to get junior into a top-notch college.The universities that mould the American elite seek out talented recruits from all backgrounds, and clever poor children who make it to the Ivy League may have their fees waived entirely. But middle-class students have to rack up huge debts to attend college, especially if they want a post-graduate degree, which many desirable jobs now require. The link between parental income and a child’s academic success has grown stronger, as clever people become richer and splash out on their daughter’s Mandarin tutor, and education matters more than it used to, because the demand for brainpower has soared. A young college graduate earns 63% more than a high-school graduate if both work full-time—and the high-school graduate is much less likely to work at all. For those at the top of the pile, moving straight from the best universities into the best jobs, the potential rewards are greater than they have ever been.None of this is peculiar to America, but the trend is most visible there. This is partly because the gap between rich and poor is bigger than anywhere else in the rich world—a problem Barack Obama alluded to repeatedly in his state-of-the-union address on January 20th. It is also because its education system favours the well-off more than anywhere else in the rich world. Thanks to hyperlocal funding, America is one of only three advanced countries where the government spends more on schools in rich areas than in poor ones. Its university fees have risen 17 times as fast as median incomes since 1980, partly to pay for pointless bureaucracy and flashy buildings. And many universities offer “legacy” preferences, favouring the children of alumni in admissions.

Nurseries, not tumbrils

The solution is not to discourage rich people from investing in their children, but to do a lot more to help clever kids who failed to pick posh parents. The moment to start is in early childhood, when the brain is most malleable and the right kind of stimulation has the largest effect. There is no substitute for parents who talk and read to their babies, but good nurseries can help, especially for the most struggling families; and America scores poorly by international standards. Improving early child care in the poorest American neighbourhoods yields returns of ten to one or more; few other government investments pay off so handsomely.Many schools are in the grip of one of the most anti-meritocratic forces in America: the teachers’ unions, which resist any hint that good teaching should be rewarded or bad teachers fired. To fix this, and the scandal of inequitable funding, the system should become both more and less local. Per-pupil funding should be set at the state level and tilted to favour the poor. Dollars should follow pupils, through a big expansion of voucher schemes or charter schools. In this way, good schools that attract more pupils will grow; bad ones will close or be taken over. Unions and their Democratic Party allies will howl, but experiments in cities such as battered New Orleans have shown that school choice works.Finally, America’s universities need an injection of meritocracy. Only a handful, such as Caltech, admit applicants solely on academic merit. All should. And colleges should make more effort to offer value for money. With cheaper online courses gaining momentum, traditional institutions must cut costs or perish. The state can help by demanding more transparency from universities about the return that graduates earn on their degrees.Loosening the link between birth and success would make America richer—far too much talent is currently wasted. It might also make the nation more cohesive. If Americans suspect that the game is rigged, they may be tempted to vote for demagogues of the right or left—especially if the grown-up alternative is another Clinton or yet another Bush.

MR. ROSENBERG: Let me welcome you here for our January update of the World Economic Outlook, for the first time launched here in Beijing in recognition of the growing importance of China and this part of the world. We’re webcasting live around the world and Chinese interpretation is available. Let me first introduce our panelists. To my right, we have Olivier Blanchard, who is the Economic Counsellor of the IMF and the Head of the IMF’s Research Department. To his right, we have Gian Maria Milesi-Ferretti, who is the Deputy Director of the department. To my very right, we have Alfred Schipke, who is our Senior Resident Representative for China.We’ll start with some opening remarks by Olivier, which I think are available now also in hard copy for those of you here in the room. Then we’ll follow with some Q&As until 11:45 when we’ll have to sharply leave because we have a commitment right after that. Just a word about the focus of the press conference. I’m sure you will have many questions about China, which of course is appropriate. But let me just remind you that this is the World Economic Outlook, so we of course appreciate also questions about the global economy including some of them online. So with that, let me pass it over to Olivier. Thank you.MR. BLANCHARD: Thank you Christoph. Good morning to all of you. Let me give you the basic theme of this update. The global economy is going through strong and complex cross currents. On the one hand, major economies are benefitting from the decline in the price of oil. But on the other, in many parts of the world, lower long-run prospects adversely affect demand, adversely affect investment, and resulting - to continue with the current analogy - in a very strong undertow.The upshot for the global economy is that while we expect growth in 2015 to be stronger than in 2014, we have revised our forecast for 2015 down a bit. So, you get this mixed message - growth is better this year than last year; we expect growth to be better this year than last year, but not quite as good as we hoped for. More specifically, our forecast for global growth in 2015 is 3.5 percent, which is 0.2 percent more than in 2014 but is 0.3 percent less than the forecast we had for WEO this year as of last October. For 2016, we forecast 3.7 percent growth. Again, a further increase in growth; but again, here we have revised down our forecast relative to where we were in October 2014.So, this is the number for global growth. But as I’ve said at a number of press conferences earlier, the number doesn’t mean much because it is really just an average for the world. At the country level, the cross currents that I’ve referred to make for a very complicated picture. For example, there are clearly good news for oil importers, but clearly bad news for oil exporters. There are good news for commodity exporters, but bad news for commodity importers. Continuing struggles for countries which still show scars from the financial crisis are slowing in their growth. Some countries are far beyond that. The countries which are linked to the dollar are in a very different situation from those which are linked de facto or de jure to the Euro or the Yen because of a change in exchange rates, to which I will come back. So, you have a lot of combinations. Each country really suffers or benefits from these various factors in ways which are different and force you to look at each country one by one.So, let me expand a bit on some of these themes. The price of oil has declined from about US$100 last June to about US$50 today. The sudden decline seems largely due to an unexpected change in the strategy of OPEC not to cut supply in the face of larger non-OPEC supply and weaker demand. We expect the factors which led to that decision to remain in place. So this is reflected in our forecast, we expect the decrease in price to be quite persistent. We expect some return, some increase, but surely not anincrease back to the levels where we were, say, six months ago.Now for oil importers, this is definitely good news. If you think about it, the effect is very straightforward. The decrease in the price of oil increases real income. It decreases the cost of production for the firms which use energy. Both lead to, in the first case, consumption; in the other case, investment. But in both cases, more spending. It’s useful to do a very simply computation and see that the effect can be potentially large.If, for example, you take a typical advanced economy, the ratio of oil consumption to GDP is about 3 percent. Now if you think that the oil bill is divided by two because of the price decline, this is an increase in real income of 1.5percent of GDP. That is equivalent to a fairly large, for example, a very large fiscal expansion. The effect is very much the same. It leads to more money in the pockets of consumers, of firms, and so on.It also leads to lower inflation, given that the price of oil is part of a consumption basket. In other times, it could be a blessing. There were times in the past when we found inflation was too high and it’s helped decrease it. Unfortunately, these are not the times today. In the current environment of already too low inflation and many central banks being at what we call the zero interest bound, they may not be able to decrease interest rates, the effect is actually adverse. Low inflation or even deflation increases the real interest rate and decreases spending. So, this effect actually is potentially negative for places like the euro zone or Japan.Now on that, I want to be clear. We think that the effect ofa decrease of the price of oil on oil importers is, a major plus; and other things equal, it will help theseeconomies have more demand and more growth. If it was the whole story, we would have revised the forecast up, but there is more to the story and I’ll come to it.Now for oil exporters and for firms involved in new forms of energy production, this is clearly bad news. To the extent that the price decrease is persistent, which is the assumption that we work under, oil exporters will have to reduce their level of government spending. Now some of them, such as Saudi Arabia, have fairly large financial buffers and therefore can afford to do it relatively slowly. Others are in a much tougher situation and do not have the buffers needed to accommodate this without a very large decrease in spending. In that context, the adverse effects on Russia or Nigeria, to take two of the most relevant examples, are likely to be very large. These countries will suffer.Some energy firms may also face financial risks. Clearly if you assumed that the price of oil was going to be US$100, it is now US$50, it may be that some investments don’t make sense and some firms will be in trouble. The point to make here is that systemic risks, namely risks from the problems of some countries or the problems of some firms, to the rest of the world seem to us to be quite limited. So, we do not see a major systemic crisis coming from the decrease in the price of oil.Another important development is the movement in exchange rates. Since August, the Dollar has appreciated in real terms, that means relative to trade partners, by about 7 percent. The Euro has depreciated by about 3 percent and the Yen by 10 percent. Now, is it good news or is it bad news?Well, while the appreciation of the Dollar is clearly going to slow down the recovery in the US, the recovery in the US is quite strong; and therefore, it will continue despite the appreciation of the Dollar. At the same time, the depreciation of the Euro and of the Yen will give a much needed boost to demand in those two parts of the world, which very much need an increase in demand and an increase in output. So again, on that, we see this as a very good development.I’ve talked about good developments. Let me now turn to the less good ones. These positive developments are offset by bad news on a number of fronts. One of the major disappointments for 2014 was the low growth in Japan. Sustained growth in Japan requires two conditions. The first one is more private demand in the short run to boost output, but that’s not enough. It also needs higher potential growth in the medium run. At this stage, potential growth in Japan is very, very low. So far, both private domestic and foreign demand have disappointed. The structural reforms which could help increase potential growth are not yet sufficient, we think, to have a substantial impact on the medium term and the future of Japan.More generally, our assessment of the underlying growth potential in many countries has been revised down. The reasons vary. For example, the effects of the decline in commodity prices, which started in 2011, on Latin America’s growth prospects are only now becoming clearer, and these countries are revising their growth projections downwards. The same is true of sub-Saharan Africa, which depends very much on commodity prices. Russia is clearly suffering from a combination of ills; from uncertainty to a poor investment climate, this was true even before the events in Ukraine; to sanctions; to lower oil prices more recently. Therefore, the future of Russia is quite bleak, and we have revised our projections down substantially.In China on the other hand, we see a gradual decrease in growth to below 7 percent in 2015. As you’ve seen we have a forecast of 6.8 percent for 2015, reflecting a welcome decision by the authorities to take care of some of the imbalances which are in place, and the desire to reorient the economy towards consumption and away from the real estate sector and shadow banking. This being said, lower growth in China will have an adverse effect on its trade partners, in particular on the rest of Asia.Now, I’ve tried to give you a sense of the many forces at work. Let me now give you a number of specific forecasts. So looking at advanced economies, our forecast reflects the increasing divergence between the United States, on the one hand, and the euro area and Japan on the other. So for 2015, we have revised US growth up to 3.6 percent, but we have revised eurozone growth down to 1.2 percent, and Japan growth down to 0.6 percent.Some of our largest downward revisions are actually elsewhere. They are in emerging markets, in particular in sub-Saharan Africa, in the Commonwealth of Independent States (CIS), and in Latin America. Revisions are smaller in emerging Asia where growth is still very high, in particular in the two leading economies, China and India.Let me end with risks to the forecast; there are always risks. The most obvious one involves stagnation in either the eurozone, or in Japan, or in both. In both, using the “three arrows”, to borrow from Abenomics, is clearly the way to go, to use monetary policy, fiscal policy and structural reforms. What is true for Japan is just as true for the eurozone as well. Risks of another episode of financial turmoil associated with the increase in short rates in the US, something which is likely to happen in the middle of the year, are surely there, but limited. Some emerging market corporate firms, which are indebted in dollars, could also prove to suffer from the Dollar appreciation. Others, which depend very much on energy production, might be in the same situation. Again, we do not think of this as creating systemic risks but it may create periods of turmoil, of uncertainty.Now, let me end on a more positive note. To be honest, assessing the favorable effects of a decline in the price of oil in the current environment is very difficulty. It depends on many factors, many of them we do not totally assess or cannot assess. So it may be that this decline may turn out to be a stronger shot in the arm, to use an expression I used a month ago in talking about it, than is currently implicit in our forecast. In other words, we have been conservative in assessing the positive effects of a decline in the price of oil. So, it could be that our forecast turns out to have been too pessimistic. If it is the case, next time we meet, I will have good news. I very much hope so. I thank you for listening to me. Now it’s time for questions.MR. ROSENBERG: So, let’s open the floor.QUESTIONER: .. a quick comment about the Switzerland, the franc, last week please. As you know, it caused financial volatility. How could the Switzerland central bank play a better role in communicating to the market?MR. BLANCHARD: So, let me make a number of remarks about what happened last week to the Swiss franc and the implications that I see. I think I see two things. The first one is that it reminds us of the strength of capital flows, inflows/outflows, and in particular what we call safe haven flows, which is that when investors become more risk averse, you get very large movements and countries can be nearly overwhelmed with the inflows or the outflows. This was clearly what was happening to Switzerland. So I think we are in a world in which these are going to happen, and the way to handle this is through probably by letting exchange rates adjust. But clearly in the case of Switzerland, they had decided that the appreciation which came from the inflows was getting too strong and they had put, what we call a floor, which is they basically had decided to peg.So I think the second lesson is that when you peg, it’s difficult to exit from a peg in a clean way. They have been accused of having done this unexpectedly but they had no choice. If you announce you’re going to do it, you’ll get the speculation, the purchase of the currency before you actually are ready to move. So, there had to be an unexpected component to it. It clearly created some turmoil, and it is an example of some of the things which can happen in the coming year. We have focused very much on the exit from unconditional monetary policy in the US. I tend to think that it might be smooth, but events like what happened last week may well happen in one form or anotherthroughout the coming years.QUESTIONER: I had a quick question about your assumptions about oil price given how central this is to the forecast. OPEC appears to have what is a somewhat self-defeating strategy, and yet you think OPEC’s not going to change that strategy. Why?MR. BLANCHARD: Well, the way OPEC worked in the past was that they would agree to restrict supply; but in the end, the burden was largely on Saudi Arabia to cut supply sufficiently to achieve the OPEC goal. As the increase in non-OPEC supply has increased, and as some of the members of OPEC have produced more as well, it would have forced Saudi Arabia to cut production very much in order to sustain the high price. I do not know what went through the mind of the Saudis, but it’s clear that the cost of cutting production enough to maintain the very high market price might have become very costly to them, even if beneficial to OPEC as a whole. It may therefore be that’s why they decided not to do it. If this is the reason, there is no reason to think that the future is going to be very different and that they are going to change their mind any time son.QUESTIONER: I have two questions. The first one is which country do you think will be the new engine in the near future? Will the US be the only engine or the so-called G2, China and US will play together to lead the growth? Or do you think there is another potential country? My second question is for the emerging markets including China, the outside environments has been very complex. The monetary policy in the major countries are all different. So do you think China and other emerging markets are facing greater pressure, for example the capital outflow, and how to solve it? Thank you.MR. BLANCHARD: So on the first, I do not like the “engine” analogy. I think each country depends for the most part of what happens there in the country itself. It is clear that it helps if some countries are growing fast because this increases exports to them. But most countries rely mostly on domestic demand, not external demand. So, this metaphor of “engine” strikes me as overused. This being said, yes, among advanced economies, the US is going to do well, much better than the euro and Japan. That’s for sure. But one has to remember that there’s a fairly large number of emerging market countries which are growing, which have growth rates much above that of the US. The main one being this one, you know, we’re talking about the revision down of the growth rate in China, but we’re talking to a revision down to 6.8 percent. So, there is no question that a lot of the action in the world is still going to come from emerging markets. I think that’s where I would leave it.On monetary policy, yes, I think that the normalization of monetary policy in the US is going to put some pressure on financial markets in emerging market countries and elsewhere. Again, I think that when it happens, it’s not going to be news. We have anticipated this for a while. So I think that some of what’s likely to happen has already happened, such as an increase in interest rates in a number of countries, such as a deprecation of exchange rates in a number of countries. I do not think that on the day on which the policy rate increases in the US, you’ll see enormous changes, unless the Fed does something very unexpected. But if the Fed proceeds as expected, I do not expect a major effect.Will there be capital outflows from some countries? Again, I think that if there were to be, we would start to see them now. I think there is some capital which went to some emerging market countries because interest rates were more attractive. Some of that capital may turn around. This is more of an issue for Latin America than for Asia. The cumulative gross inflows to Asia have been relatively stable, relative to the pre-crisis period. So, I don’t think that there’s an enormous amount of capital waiting to go back to the US. Again, I do not see this as a major issue.QUESTIONER: I have two questions on Europe’s economy. What are the main factors that contribute to a rise in Spain’s growth forecast in 2015, and to maintain it in 2016, while so many European countries have been revised down? My second question is how do you see the political situation in Greece and in Spain, the emerging of parties, like Podemos, its proposals on how to restructure the eurozone debt? How could this affect Europe’s economy? Thank you.MR. BLANCHARD: Good. I’ll take this one, but Gian Maria may add something. Spain indeed is going to have relatively high growth by euro standards - not by Chinese standards, but by euro standards - next year, and that’s good news. But we have to remember that theu nemployment rate is still much above 20 percent. So there’s a very long way to go; hence even that type of growth rate is not going to decrease unemployment very fast.Why is there growth? Well, because things have happened in Spain as a result of the crisis, good things. The first one is that there has been a substantial improvement in competitiveness due both to an increase in productivity and to a decrease in wages. So, exports in Spain are doing well. That’s helping. On the domestic front, something interesting is happening. Some of us were worried that deflation would kill demand, but there seems to be more optimism in the air with a positive growth rate. So the saving rate is coming down, consumers are spending more, and domestic demand is fairly strong. So, these two factors have the effect of increasing growth. In situations like this, there is a virtuous cycle to it, which is more confidence in the future leads to more investment, more consumption; and so growth can continue to take place for a number of years.On your second point, as I said, the unemployment rate in Spain is still much too high; and in Spain, as in many other countries, this is leading to the rise of parties which either do not want to be part of the euro or have populist positions. That’s something that we have to worry about. That’s why really growth in the eurozone is of the essence, if only for political reasons. Do you want to add something?MR. MILESI-FERRETTI: I would just add oil. Spain is a net oil importer obviously. Most demand comes from that. Most demand and disposable income comes from that channel.QUESTIONER: … on the Chinese economy…MR. BLANCHARD: So I shall make just one remark, and then pass the microphone to Alfred. Our forecast was for 7.4 percent, so we got it exactly right.MR. SCHIPKE: Growth, of course, is moderating, but that is for a good reason. What we have seen is an adjustment that is taking place with moderating credit growth, which some here refer to “total social financing”, and of course adjustment in the real estate sector. We have revised our growth projection downwards from 7.1 in October to 6.8 percent in part because we see this healthy adjustment in the real estate sector going forward.This is going to be a multi-year process, where of course investment demand will be slower in order to facilitate the adjustment. The risk is that the government is faced with three tasks at the same time. On the one hand, it is trying to reduce vulnerabilities in the economy. At the same time, it tries to facilitate the adjustment that is going on. But the third point is also very important, that it tries to avoid a too sharp slowdown. So, macro policies need to be carefully calibrated.MR. ROSENBERG: I’ll take one online question. The question is whether further stimulus from the ECB through quantitative easing will help the European economy.MR. BLANCHARD: I think that the effect of quantitative easing have to a large extent already happened. The investors have known for a while that this was likely to come, and this has already led to a flattening of the Euro curve in the eurozone indicating the anticipation of QE and is probably behind much of the depreciation of the Euro. So in a way, QE has already worked.Now for it to actually work, it has to be that when the ECB announces it, it corresponds to the expectations of investors, more or less. The risk is that it’s too small and the investors will be disappointed, and some of what happened will be reversed. My expectation is that the ECB will do something more or less consistent with what investors have anticipated. Therefore, the effects we have seen will continue. But in a way, the effects have already happened.QUESTIONER: You revised down, it was very significant, for Latin America and Brazil. I would like to ask you why and if specifically about Brazil and also Latin America in general, beyond commodities was also related to uncertainties on the economic policies of the countries. Thank you.MR. BLANCHARD: So I shall start, and then Gian Maria will speak more specifically about Brazil. It’s true that we have revised growth down in Latin America quite a bit. I think what’s happening in Latin America, the common factor is indeed the declining commodity prices. What was thought to be potential growth earlier in the 2000s was largely due to strong commodity prices. As commodity prices have declined, which they have done since 2011, countries have realized how much of the growth really came from high commodity prices.This is a learning process. This is why the revisions tend to come out with the same sign quarter after quarter. We’re learning that the high growth of the early 2000s just could not be sustained. That’s common now. Each country reacts to these decreases in different ways, some better than others. But I think that’s a context in which you have to think about Brazil. Now in the case of Brazil, there are indeed specific factors, which Gian Maria will talk about, which explain why the forecast for Brazil is so low.MR. MILESI-FERRETTI: Another couple of points on Brazil. So of course the forecast for 2015 depends on what has happened, particularly in the second half of 2014; and activity has been quite weak, particularly investment. You mentioned uncertainty and part of the uncertainty was initially related to the elections. That uncertainty was resolved but there has been a fallout from the investigation on Petrobras that clearly has affected confidence and has added to uncertainty, for example related to investment plans of the company. That is also affected by what is happening to oil prices. Finally, what I would mention is that monetary policy has tightened to deal with inflationary pressures, and that clearly tends to put a break on domestic demand. So low investment, weak confidence, tighter monetary policy are factors that have shaped our assessment of the forecast, in addition to this rethinking of the effects of weaker commodity prices.QUESTIONER: I have two questions. The first is do you think the Chinese economy in the near future, especially in 2015, will benefit from the Chinese anti-corruption and why, especially what specific areas will benefit from the anti-corruption? The second is I notice that you have said in the Financial Times in 2009 that the China and United States will play an important role in the global economy recovery. And facing a maybe 7 percent or even below 7 percent growth rate, do you still think so?MR. SCHIPKE: Maybe just a quick comment on that. Clearly good governance and the rule of law are critical for the efficient allocation of resources. We know that corruption can lead to misallocation of resources. In that respect, addressing those issues can be quite beneficial.MR. ROSENBERG: Okay, maybe I’ll take another online question here. The question is about Africa and what the decline of oil prices will mean there and what the IMF is prepared to do to help those countries who are negatively impacted by the oil price decline.MR. BLANCHARD: Most African countries are oil importers and so on that, are helped. Some countries are not, and the main example is Nigeria. Nigeria will have to adjust. I do not know at this stage whether they can adjust on their own or they might need a program from the Fund. If they did, you know, any member is welcome to come. At this stage, I have no information about it.QUESTIONER: Do you think the present world commodity prices are caused purely by supply and demand or it is because the appreciation of Dollar and maybe leading capital flowing into Dollar related assets. Will this trend continue? Thanks.MR. BLANCHARD: So I think the answer is yes, the appreciation of the dollar plays a role because you can think of the price of oil as being determined in terms of a market of currencies so that if the dollar appreciates relative to that basket, then the price of oil in terms of dollars will actually tend to come down. So, there is some effect which has to do with the shifting currencies. Beyond that, we do not think that the decline in the price of oil is due to speculation in the sense of financial speculation. In the sense of financialization of the market, we think it reflects straight supply and demand factors of the usual variety, countries needing less oil and some countries producing more.MR. ROSENBERG: Will the oil price trend continue?MR. BLANCHARD: It’s very difficult to know what the trend for the price of oil is. There are many factors. So at this stage, I’ll refrain from giving you a forecast, even the long-run forecast.QUESTIONER: My question is that since you predict that China’s economy will slow down, so what would be the industries or areas that make the largest contribution to this slowdown? And what are the drivers for the growth of Chinese economy in this year? Thank you.MR. SCHIPKE: We clearly see the real estate sector as being one of the sectors that needs to continue to adjust. There are, of course, other sectors that suffer from oversupply; and those will probably also have an adverse implication on growth. But then there are also many upsides that can be mobilized, especially if the 3rd Party Plenum is being implemented, and that relates especially to the service sector. I think further liberalization of the service sector, allowing competition in the sector, can have significant gains. So there are a number of areas, but the service sector is probably one of them to highlight.MR. ROSENBERG: Let me take one more online question and then I’ll turn it to our last question from the audience. This is a question about the economic outlook for India. What is your impression of the economic reforms undertaken by the new prime minister, Narendra Modi?MR. MILESI-FERRETTI: If we look at our global forecast for India, let me start with that, it is roughly unchanged. So it reflects on the one hand, a positive effect from oil prices, given that India is a large net oil importer. And the other effect, economic activity has been a bit slower than we expected and you also have somewhat slower external demand. I think the reform plans of the new prime minister are promising. We’re going to have to see the speed of implementation. The effects on the economy are going to be clearly due to the extent that these are structural reforms accruing gradually over the medium term. But again, a key is going to be implementation.QUESTIONER: I wanted to know if the recent volatility in the markets will push back the Fed to raise their hikes in the long term? Because you were talking about mid-year. Do you see that being pushed back?MR. BLANCHARD: I cannot speak for the Fed. But my sense is that if anything, volatility in the markets, say due to what happened in Switzerland, suggests that predictability of monetary policy is of the essence. So if anything, I suspect this will lead the Fed to be extremely clear about what its intentions are and not change the date that they have in mind, unless events force them to.QUESTIONER: …Your report says you expect less of a policy response from the Chinese to monetary growth. So are you assuming consensus to interest rates cuts? Are you assuming less than that or what’s your assumptions for monetary policy?MR. BLANCHARD: For the details, you’ll have to talk to Alfred. I think the general principle is that they clearly were willing to take measures to maintain some growth even if housing turned out to be worse, and the fact that there is this gift in effect from the price of oil allows them to obtain the same effects with...

Former US treasury secretary also says eurozone QE has come too late to lift the region off the reefs on its own.

By Ambrose Evans-Pritchard, in Davos

12:44PM GMT 22 Jan 2015

Analysts expect the US 'to embark on a sustained economic upswing in the coming quarters'Photo: AFP

The United States risks a deflationary spiral and a depression-trap that would engulf the world if the Federal Reserve tightens monetary policy too soon, a top panel of experts has warned.

"Deflation and secular stagnation are the threats of our time. The risks are enormously asymmetric," said Larry Summers, the former US Treasury Secretary.

"There is no confident basis for tightening. The Fed should not be fighting against inflation until it sees the whites of its eyes. That is a long way off," he said, speaking at the World Economic Forum in Davos.

Mr Summers said the world economy is entering treacherous waters as the US expansion enters its seventh year, reaching the typical life-expectancy of recoveries. "Nobody over the last fifty years, not the IMF, not the US Treasury, has predicted any of the recessions a year in advance, never."

When the recessions did strike, the US needed rate cuts of three or four percentage points on average to combat the downturn. This time the Fed has no such ammunition left. "Are we anywhere near the point when we have 3pc or 4pc running room to cut rates? This is why I am worried," he told a Bloomberg forum.

Any error at this critical juncture could set off a "spiral to deflation" that would be extremely hard to reverse. The US still faces an intractable unemployment crisis after a full six years of zero rates and quantitative easing, with very high jobless rates even among males aged 25-54 - the cohort usually keenest to work - and despite America's lean and efficient labour markets. Mr Summers warned that this may be a harbinger of deeper trouble as technological leaps leave more and more people shut out of the work-force, and should be a cautionary warning to those in Europe who imagine that structural reforms alone will solve their unemployment crisis. "If the US is in a bad place, we are short of any engine at the moment, so I hope you are wrong," said Christine Lagarde, the head of the International Monetary Fund. Mrs Lagarde said the IMF expects the Fed to raise rates in the middle of the year, sooner than markets expect. "This is good news in and of itself, but the consequences are a different story: there will be spillovers. One thing for sure is that we are in uncharted territory," she said. Worries about the underlying weakness of the US economy were echoed by Bridgewater's Ray Dalio, who said the "central bank supercycle" of ever-lower interest rates and ever-more debt creation has reached its limits. Interest rate spreads are already so compressed that the transmission mechanism of monetary policy has broken down. "We are in a deflationary set of circumstances. This is going to call into question the value of holding money. People may start putting it in their mattress." Mr Dalio said the global economy is in a similar situation to the early Reagan-era from 1980-1985 when the dollar was surging, setting off a "short squeeze" for those lenders across the world who borrowed in dollars during the boom. There is one big difference today, and that is what makes it so ominous. "Back then we could lower interest rates. If we hadn't done so, it would have been disastrous. We can't lower interest rates now," he said. “We’re in a new era in which central banks have largely lost their power to ease. I worry about the downside because the downside will come,” he said.Mr Dalio said Europe is already in such a desperate predicament that it may have to go beyond plain-vanilla QE and start printing money to fund government spending - what is known as "helicopter money" in financial argot. "Monetisation is a path to consider," he said. “If the moderates of Europe do not get together and change things in a meaningful way, I believe there is a risk that the political extremists will be the biggest threat to the euro," he said. Mr Summers said QE in Europe will not do any harm - and might help a little - but comes too late to lift the region off the reefs on its own. “I am all for European QE, but the risks of doing too little far exceed the risks of doing too much. It is a mistake to suppose it is a panacea or that it will be sufficient."

“It’s morning again in America” — that was a campaign slogan by President Ronald Reagan in 1984. But, in retrospect, the average American has been stuck since the Reagan era in a predawn darkness of stagnation and inequality, and we still haven’t shaken it off, particularly since 2000. Inequality has increased further under President Obama.

That’s the context for Obama’s call, in his State of the Union address, for greater economic fairness. But first, the caveats. His proposals are dead on arrival in Congress. They won’t be implemented and probably won’t change the public’s thinking: Research by George C. Edwards, a political scientist, finds that presidential speeches rarely persuade the public much.

Remember the 2014 State of the Union address? Of course not. Of 18 proposals in it, there was action on two, according to PBS. Or Obama’s passionate call in his 2013 State of the Union for measures to reduce gun violence? Nothing much resulted, and the word “guns” didn’t even pass his lips this time.

Yet the bully pulpit still can shape the national agenda and nag at the American conscience. I don’t fully agree with Obama’s solutions — how could he skip over early-childhood interventions?! — but he’s exactly right in the way he framed the inequality issue: “Will we accept an economy where only a few of us do spectacularly well?”

Some background. Even with the global Great Depression, the United States performed brilliantly in the first three-quarters of the 20th century, with incomes and education mostly rising and inequality flat or falling — and gains were broadly shared by poor and rich alike. High school graduation rates surged, G.I.’s went to college, and the United States led the world in educational attainment.

And, in part of this remarkable era, the top federal income tax rate exceeded 90 percent. Republicans might remember that point when they warn that Obama’s proposals for modestly higher taxes would savage the American economy.

Then, for average Americans, the roof fell in around the end of the 1970s. The ’70s were “the end of normal,” the economist James K. Galbraith argues in a new book of that title. Afterward, the economy continued to grow over all, but the spoils went to the wealthy and the bottom 90 percent barely benefited.

By some measures, education — our seed corn for the future — has pretty much stalled. More young American men today have less education than their parents (29 percent) than have more education (20 percent). Among industrialized countries as a whole, 70 percent of 3-year-olds go to preschool; in the United States, 38 percent do.

I wonder if the celebration of unfettered capitalism and “greed is good” since the Reagan era didn’t help shape social mores in ways that accelerated inequality.

In any case, Reagan was right on one point — “the best social program is a productive job” — and Obama offered sound proposals to increase incentives for work. Better child-care and sick-leave policies would also make work more feasible. The United States is the only country among the 34 in the Organization for Economic Cooperation and Development that

Early-education initiatives poll well, and some of the leaders in programming have been red states like Oklahoma. So while the Obama agenda is mostly for show, expansion of preschool could actually occur at least at the state level.

Obama rightly heralded the fall in teenage pregnancy rates. But he had little to do with it (although the MTV show “16 and Pregnant” played a role!), and about 30 percent of American girls still get pregnant by age 19. Making reliable birth control available to at-risk teenagers would help them, reduce abortion rates and even pay for itself in reduced social spending later.

In America, we have subsidized private jets, big banks and hedge fund managers. Wouldn’t it make more sense to subsidize kids? So if higher capital gains taxes can pay for better education, infrastructure and jobs, of course that trade-off is worthwhile.

Congressional Republicans seem focused on a pipeline that isn’t even economically viable at today’s oil prices. Let’s hope that the national agenda can broaden along the lines that Obama suggests, so that the last 35 years become an aberration rather than a bellwether.

This week we have begun to see signs of risk-on in the broad market, and the safety trade into gold is weakening.

The upcoming Greek election on Sunday, and to a lesser extent the Federal Reserve meeting on 27/28 Jan, may result in some gold price volatility.

I believe we are very close to at least a local top in the gold price, and expect a decline to start within the next week.

After the moves we saw in the last two weeks, what followed has been relatively straightforward and quiet in comparison. There was no real forecast in my last article as although I expected a period of consolidation, with sideways to down price movement, I could not rule out a further short term rise either.This week gold did not make huge swings, opening at $1280 and finishing at $1294, and with not much in between. Whilst I can see us achieving a small further gain early on in the week, I maintain that we are close to at least a local top, and potentially the start of a decline to new lows.Although the last 7 days have been quiet, there have been some big changes to positioning within the market, and announcements made regarding Central Bank policy.Let's review some of the items mentioned last week:Is The Safety Trade Over?Last week I talked about upcoming decisions being made by the ECB and the potential for a 1T EUR Quantitative Easing programme, with a view to the effects this would likely have on currency and by extension upon gold (NYSEARCA:GLD). My feeling was that any move by the ECB to start buying bonds would weaken the Euro further, prompt the Dollar to rise, and put pressure on gold bulls.On Wednesday we had a soft announcement by two ECB board members hinting to the press that they would indeed start a round of QE at €50B per month, and in a move no doubt designed to add a little cherry to the top of the equity rally cake, Mario Draghi announced on Thursday that the ECB would buy not €50B but €60B of bonds each month starting from March this year through September 2016.The European equity markets had been rallying for days prior to the shock announcement that the whole world knew was coming, but of course they rallied further on the news, and we are now seeing signs of risk-on behaviour across the board.Volatility within equity markets due to changes in central bank policy seems to be receding - I say seems because when the announcement was made, initially there was a pronounced nervousness displayed by the US indices to join the rally party, and I remain unsure about the prospects of a sustained forthcoming rally in the S&P500.The question we now need to answer is whether the safety trade is over and buyers of gold will dry up.Prior to the official announcement, gold broke support and dropped to $1279, but then quickly rallied back up to $1308 as the S&P500 (NYSEARCA:SPY) bobbed up and down looking for clear direction. However, when the equity markets really got going, gold fell to $1284 but finished the week at $1294 for a gain of just over 1%.As expected the Euro dropped, but fell further and faster than the week before, briefly piercing the 1.1192 level given in my last article which suggests the level won't hold in the future. This is looking more and more like a slow motion train wreck each time I go to check the chart:

(click to enlarge)

I keep hearing people say they expect a bounce soon and are looking to buy, but I would caution them not to catch this particular knife - in my opinion the Euro is going much lower much quicker than people seem to realise.On the back of the drop in the Euro the US Dollar rose and put some pressure on the gold price, but this only became evident when US markets started to rally hard, indicating that the safety play is more about equity market performance than dollar movement.Whilst I am not discounting the potential for further gold volatility on Fed day this coming week, in the main I feel we now have only one last hurdle to jump which is of course the Greek elections this Sunday.As I write this article (Saturday) Reuters is reporting a lead in the polls for Syriza, and stating they look odds on for a win. I believe this could result in a short term spike up in the gold price, before gold completes this rally and begins to decline, and I will personally be using this Sunday night spike (if it comes), and/or movement on Fed day, to add to my short positions.Will the Dollar Pull Back Soon and Ease Pressure on Gold?This is another assertion I am hearing a lot, whereby folks seem not to believe in the veracity of this rapid rise in the US Dollar, and expect it to collapse any moment now. I can understand this attitude to some extent, as the Daily Sentiment Indices point to an unhealthy number of US Dollar bulls and the trade has become massively over-crowded, but trade is not the only consideration here.In previous articles I touched upon the dollar being the safe haven of choice, and those watching their domestic currencies decline would seek shelter in a currency that is strengthening against their own. Additionally, the US bond and equity markets have far outperformed their rivals overseas and this makes them more attractive to foreign investors, so a greater percentage of capital is buying dollar denominated assets rather than those available in their own countries.All of this is absolutely true and I expect the trend to carry on, but there is another reason for dollar strength. When the Fed lowered interest rates, the US Dollar became attractive to those wishing to issue debt, as to many it would mean having to pay less interest than if the bond was issued in their own domestic currency. Depending on where you get your statistics from, non-domestic USD debt is quoted as being anywhere between 6 and 9 Trillion dollars.Obviously, if the bond is dollar denominated, repayments have to be made in dollars also. Those issuers who have failed to use the money in an activity that generates dollar income will be converting their own currency into the dollar to make these repayments. If the dollar weakens it means they convert less of their own currency; if the dollar strengthens they effectively pay more.This makes them net short the dollar overall i.e. the more the dollar strengthens, the more expensive the debt gets to keep servicing, and the more they lose on the deal. I believe this situation, coupled with all the other reasons people have for buying dollars or dollar denominated assets, is the real reason that demand for dollars is growing at an exponential rate and will continue to do so.This is evidenced on the chart below, which in normal circumstances would have at least pulled back a little to work off overbought technical readings, but just keeps moving higher:

(click to enlarge)

As with those thinking of buying the Euro, I would caution people not to try shorting the Dollar. While there may be small corrections in store, I expect these to be shallow and brief before climbing further, eventually testing the 120 level and conceivably breaking higher.With the kind of strength I am expecting in the US Dollar, and the fact that the safety trade appears to be over, I find it hard to believe that gold will continue to rise at the same time.Should there be further Central Bank shocks we may get short covering rallies in gold to get the bulls all fired up, but I think the overall trend is still down, and that gold will eventually make new lows as a result.Data PointsFor those wishing to see an explanation of some of the data points we are about to cover, please click here.GOFOThere is currently no backwardation in place at present, and this is despite the rally gold has achieved in a relatively short space of time. It indicates that there remains ample physical supply on the market and suggests that the rally was fuelled by speculative buyers of paper contracts, rather than a bigger entity buying more than normal levels of the actual metal.When the SNB shocked the market, and equity markets were on the downturn, it triggered a run to safety and gold was a recipient. If a government had wanted to shore up their own currency with an extra purchase of gold, it is likely we would have seen negative GOFO rates at least temporarily.My own opinion is that the calls purchased that drove the price of gold higher are in the weaker type hands, and any subsequent decline in the price will trigger selling.The Commitment of Traders report seems to agree.COTI have been waiting all week to see the results of Friday's COT report. Like many who commented on last week's article, I expected to see a huge change in positioning based upon the volatility we experienced. I don't think people will be disappointed, well perhaps the bulls may be:

COMMERCIAL

LARGE SPEC

SMALL SPEC

LONG

SHORT

LONG

SHORT

LONG

SHORT

120,946

298,756

223,257

60,802

43,445

28,090

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

CHANGE

-8,490

+31,644

+30,298

-1,931

+4,461

-3,444

As we can see from the table above, rather than lightening up on their short contracts and getting more long as many expected, for the 4th week running the Commercials increased their net short position, this time to the tune of 40,000+ contracts - the biggest one week change I can remember in some time.The last time the Commercial category had this number of short contracts on their books, we were one week away from the top at $1395 in mid-March 2014. Gold subsequently declined to the lowest point to date in this bear market (our $1132 November low) over the next 8 months.Last week I noted that the commercial positioning leads me to believe that they see lower lows on the horizon for gold, and the numbers this week reinforce that statement. Do you really think the historically most successful trader category would be positioned as such if they believed gold to have bottomed at $1132?Certainly we can rally higher over the next month or so, but all in all I am happy to maintain the view that we are not yet ready to start the next phase of the bull market, and will eventually see lower gold prices.MinersBoth the gold mining majors (NYSEARCA:GDX) and the juniors (NYSEARCA:GDXJ) made losses overall last week despite the net gain for gold. As noted in previous articles, this is not unusual as stocks tend to lead the commodity, and gold mining shares often start their declines prior to the decline in gold.If we do get a further spike up in gold early this week, we may find GDX rises a little higher, but I would be surprised to see it break the 23.50 level, and there is a relatively good chance it has topped already.For GDXJ the equivalent level is 31.75 but with the juniors I feel that it is more likely they have topped and started their decline. Their underperformance of late is a growing sign that people are not prepared to take the same level of risk as they perhaps might with the majors, and is further evidence that we may be seeing a local top in gold sometime soon.Some of the industry heavyweights are very close to long term resistance with this rally we have seen in January, and unless they can breakout above resistance it is likely that GDX will stall without their participation.Considering everything written above, I am relatively sure we will be seeing a decline in the mining ETFs this week.Gold ChartGold is very close to resistance here, and although I think it has a decent chance of going a little higher, I would be surprised to see it break the July 2014 $1345 high. Fibonacci resistance starts at $1313, moving up to $1340, and we have trendline resistance currently at $1328.

(click to enlarge)

Thus far we have nothing clearly indicating a local top has been achieved, but we have now gone as high as $1308 which is very close to our first fib target, so I cannot rule it out completely. It is not an easy call, as with the Greek election on Sunday we may see that panic spike higher to complete the move, and then start our decline.Once we do have a confirmed top in place, I believe we will head to $1231 reasonably quickly. The form of the decline will dictate whether or not we go higher after that. A corrective decline could see us holding support and rallying up as high as $1430 to complete wave 4, whereas an impulsive decline would indicate wave 4 is complete and could see us heading to test the November low, and possibly make new lows. As usual I will update thoughts and charts in the comments section throughout the week.I wish everyone Good Luck in their post-Greek election trading!

United States Treasury secretaries routinely say that they favor a strong dollar, regardless of circumstances or economic conditions. And the dollar is strong right now, thanks in no small part to actions by foreign central banks.

The European Central Bank significantly loosened its monetary policy on Thursday, in the process driving down the euro and bolstering the dollar. Measured against a basket of currencies, the dollar’s value has soared 19 percent since May, and the momentum seems to be building.

“A strong dollar has always been a good thing for the United States,” Treasury Secretary Jacob J. Lew declared not long ago, a position that he has restated frequently.

But is it really a good thing — for the United States and the global economy?

In 2011, Timothy F. Geithner, then the Treasury secretary, said, “A strong dollar will always be in the interest of the United States.” He uttered that mantra even though leading economists at the time were noting that the dollar was actually weakening and the shift was in the best interest of the United States. A weaker dollar meant that American exports were more competitive in world markets and consumption of imported goods was declining. In turn, that trimmed America’s trade and budget deficits, stimulated the domestic economy, and helped to spur job creation.

A weaker dollar was, arguably, one of the reasons for the health of the American economy, compared with other nations. The stronger dollar that has resulted from that period of American advantage could reverse some of the progress that the United States has made. That’s not obviously a good thing for the United States.

Paying ritualistic homage to the dollar isn’t limited to recent Democratic administrations. After leaving office, Paul O’Neill, Treasury secretary under President George W. Bush in 2001 and 2002, recalled those years: “I was not supposed to say anything but ‘strong dollar, strong dollar.’ I argued then and would argue now that the idea of a strong-dollar policy is a vacuous notion.”

No matter. The dollar is a potent symbol of America’s global power, and United States government officials habitually bow to it, even when their comments aren’t firmly linked to policy or geopolitical reality, said Eswar S. Prasad, a Cornell University professor of economics who is the author of the “The Dollar Trap,” a study of the dollar’s role in global finance.

“The notion that a strong country always has a strong currency isn’t something that many countries subscribe to,” he said. As a continental power that doesn’t rely on exports to the extent that many other nations do, he said, “the United States has been able to sustain the illusion of the importance of a strong currency, but really, when the dollar is fairly strong, as it is now, it’s a mixed blessing for the economy of the United States.”

Disentangling the factors that affect foreign exchange rates — and that make the dollar strong — isn’t simple. Supply and demand in the marketplace can be masked temporarily by canny trading and improper market activities.

For the most part, though, it appears that the dollar has strengthened for substantive reasons: It has become more attractive than other currencies, on a relative basis, because it’s linked to the American economy, which has been growing more rapidly than those of most other developed countries.

What’s more, the monetary cycle in the United States has diverged from that in many other countries: The Federal Reserve has signaled that it is considering interest rate increases, and it has ended bond purchases — or quantitative easing. That reflects the growth of the American economy, a big contrast with Europe and Japan, which are struggling. Last week, the European Central Bank embarked on a new, 1 trillion euro ($1.16 trillion) campaign of quantitative easing, and it has been further lowering interest rates that are already extraordinarily low and sometimes in negative territory.

In Japan, the central bank has also been aggressively expanding its quantitative easing program and keeping interest rates low.

Furthermore, the dollar has worldwide appeal as a “safe haven,” a destination currency in times of global trouble. That role is likely to become more crucial now that the Swiss franc, another traditional haven, has begun to gyrate wildly in value. That has occurred since Jan. 15, when the Swiss National Bank eliminated the franc’s peg to the euro and started charging banks interest of 0.75 percent to hold their reserves.

The Greek elections on Sunday, which have already unnerved financial markets, could well add more immediate luster to the dollar.

Whether this is truly good for the United States is another matter.

There are some clear benefits, which Mr. Prasad enumerated. Global money flooding into dollar-denominated investments tends to lower interest rates in this country. That typically makes home mortgages cheaper, and a variety of assets more valuable, including houses, bonds and stocks.

Americans abroad can buy more with dollars, and imported goods like clothing are cheaper. Add that to the windfall for consumers coming from lower oil prices and it could stimulate the economy.

But there are obvious problems, too. There could be negative spillover effects in emerging markets, where corporate debt has increasingly been dollar-denominated. As that debt becomes more expensive in local currencies, financial stress is likely to heighten.

American exports tend to become more expensive abroad, too, hurting businesses that make them and reducing the rate of job creation. “If the dollar were to become much stronger and it persisted, there will be an outcry,” Mr. Prasad said.

More than 40 percent of revenue for the companies in the Standard & Poor’s 500-stock index come from abroad, and those with significant foreign operations will have earnings problems, if they haven’t hedged their currency exposure.

Johnson & Johnson last week reported that its earnings were impaired by transactions in foreign currencies that translated into fewer dollars. Some Wall Street analysts have begun to downgrade their estimates for companies with foreign exposure, while raising their price targets for companies based entirely at home.

Bespoke Investment Group offered a good example of how two companies’ fortunes have diverged in the last year, as the dollar has strengthened. In 2008, Altria, the old Philip Morris tobacco group, divided in two, based mainly on revenue source: Altria’s revenue is generated in the United States; Philip Morris International’s revenue is generated abroad.

Since the dollar began to rise last year, Altria Group, the domestic company, has skyrocketed, while Philip Morris, the international company, has “flatlined,” Bespoke said in a report to clients.

All of which suggests that a strong dollar isn’t entirely and always good, whatever the Treasury secretary says. But it is something we will have to learn to live with.

Gold And The Dollar Show Coinciding Strength (Though The USD Is Less Than Halfway Done)

Jan. 22, 2015 1:39 PM ET

by: Mercenary Trader

Summary

The “big news” for this week – regarding the tentative size of the ECB’s quantitative easing program – was leaked a day early.

The EURUSD, already in a waterfall decline, half-heartedly flailed around a bit. European equities remain in a stairstep down-trend.

Could the upside move in gold continue? It’s not out of the question. The extraordinary thing would be strength in gold and strength in the USD at the same time.

(click to enlarge)The "big news" for this week - regarding the tentative size of the ECB's quantitative easing program - was leaked a day early (see prior piece MacroView reference), and markets responded more or less with a shrug. The EURUSD, already in a waterfall decline, half-heartedly flailed around a bit, but neither screamed higher nor plummeted in freefall on news of a €50 billion per month bond-buying regime. More details will arrive soon as to what degree Germany will play ball (and whether the market's emotional response will increase).European equities, meanwhile, remain in a stairstep down-trend - as shown via SPDR Euro STOXX 50 (NYSEARCA:FEZ) below. We are short FEZ and were glad to see minimal fireworks on the early announcement. The immediate reaction of FEZ to the bond-buying was mildly bullish… but such that the near-term trend could easily shift, back to the bearish primary trend, especially with significant levels of overhead supply and a clear downtrend intact.

(click to enlarge)There remains a possibility European equities break out to the upside, leading to a renaissance in the Wall Street "trade du jour" (long Europe) as evidenced by recent enthusiasm on trading desks. For price to confirm this shift in stance, FEZ would have to convincingly break the current downtrend, hold the breakout, and show clear signs of sustainable follow through on a new bullish trend. We are skeptical something like this will happen, especially given the poor response to the initial "euro QE" preview. As it stands we do not have to make a bull/bear decision: The bear scenario is plausible, and if price action confirms we will pyramid shorts accordingly.One area where price has forced us to change our minds is gold. As PTJ has put it, "Price comes first; fundamentals come second." We agree with this basic tenet because at best you might possess 70% of the pieces; unknown factors hiding in the other 30% could be enough to turn your thesis on its head. As such, we are no longer short gold and maintain long positions in the various gold and silver mining indices - Market Vectors Gold Miners (NYSEARCA:GDX), Market Vectors junior Gold Miners (NYSEARCA:GDXJ) and Global X Silver Miners (NYSEARCA:SIL). Gold's breakout action is odd in juxtaposition with a super strong USD, but has plausible explainability in light of other factors (e.g. QE anticipation / eurozone capital flight).

(click to enlarge)Could the upside move in gold continue? It's certainly not out of the question. The extraordinary thing would be strength in gold and strength in the USD running at the same time. On the other hand, we live in extraordinary times… in a world where EURUSD could conceivably fall to 85 cents (if things get bad enough across the pond), and in which capital flight is occurring in other major currencies besides the USD, most anything could happen. Non-USD gold flight could explain it.As for EURUSD falling all the way to 85 cents, this is tied to the "in for a penny, in for a pound" idea: Some argue that, once "euro QE" begins, they'll be forced to keep going (and going…) especially if mighty Germany itself is hit by economic slowdown, born of deflationary impacts via China malaise and competitive currency devaluations in the yen and won.By the way, speaking of USD strength… do we even need to show you (again) that crazy 25-year bullish dollar chart? The greenback continues to go vertical… and the move may be nowhere near done. David Kotok of Cumberland Advisors:

BCA Research observes that "the U.S. dollar moves in big cycles." They estimate that USD "trade-weighted" strengthening is up 23% so far in this cycle. BCA notes that the cycle in the 1990s involved a total move of 53%. The move of the late 1970s to mid-1980s was 57% according to their estimates. They add JPMorgan Chase as a research source in their calculation. If BCA is correct, we may not be even halfway through the strengthening move. And Switzerland's action is not a significant weight in the [total] calculation.

On the commodity currency front, the dollar / loonie took off like a rocketship this week… the USDCAD chart, taking a cue from treasury bonds, looks like a spaceship leaving earth. We are long USDCAD, which goes up as the Canadian dollar weakens, but short AUDUSD (as shown above) which goes down as the Aussie dollar weakens. We show you AUDUSD because a potential entry or pyramid position is at hand… indeed we just triggered a pyramid short in the Aussie even as this Tactical View was being completed. (For access to all of our positions, including daily email commentary, morning trade setups, and real-time fill reporting, check out the Mercenary Live Feed.A simple memory trick for currency pairs by the way: The first currency in the pair is like the numerator (the top part of the fraction), while the second currency is the denominator (or the bottom of the fraction). As such, when USDCAD sees the USD getting stronger, it goes up as "USD" pulls it upward, like a balloon lifting an object. But when AUDUSD sees the USD get stronger, the now-denominator USD acts like a heavy weight, sinking "AUD" like a stone in a pond. So now you can see why EURUSD drops when the euro weakens… the "USD" denominator sinks it… and also why EURCHF went down when the peg was broken (the "CHF" did the same thing).The key is that whichever currency of the pair is strongest at the time determines whether the pair moves up or down - if the numerator (first half) currency is stronger, the pair rises (like a balloon); but if the denominator (second half) is stronger, the pair sinks (like a stone in water). Once you grok this, you can glance at any odd currency pairing (for example AUDJPY) and have a sense of what the pairing means, in terms of who is trending strong and who is trending weak…

(click to enlarge)Speaking of weakness potential, US Treasuries remain super strong (as shown above), but may be due for a breather now that "euro QE" is in the books (or the early preview of such anyway). We remain long USTs [via our short position in ProShares UltraShort 2-+ Year Treasury (NYSEARCA:TBT), the inverse treasury bond ETF], but have since lightened up a bit more in anticipation of a pullback in the bigger trend. (The market could yet keep climbing, of course, which is why we still have a long position on, having taken an additional round of partial profits rather than full.)

(click to enlarge)On the US equity side, we are short Financial Select Sector (NYSEARCA:XLF) and SPDR S&P Bank ETF (NYSEARCA:KBE), and also short small caps - via Direxion Daily Small Cap Bull 3X (NYSEARCA:TNA) - plus varied long positions on the individual equity front. Bulls will have a very hard time overcoming the bearish outlook in financials: In historic terms, it is hard for a bull market to get its mojo back when the financials have decisively rolled over.Large cap stocks as shown below via Direxion Daily S&P 500 Bull 3X (NYSEARCA:SPXL) are also feeling the pain. The S&P 500 is now close to registering a downside 20 / 50 day moving average cross (as shown by the gold and green lines). We see added potential for large cap weakness as the profit-cutting impact of USD strength, anticipated in these pages, has finally begun to register in corporate outlooks. Companies like Tiffany's (NYSE:TIF) have seen large share price declines on reduced outlooks and lower sales, blamed on sharp USD appreciation and lessened emerging market activity. The WSJ has also run headlines this past week with titles like "Dollar Squeezes U.S. Firms" and "How the Rising Dollar Has Pressured U.S. Manufacturers."If BCA Research is correct (and we believe they are), the USD run could be less than halfway through. If this is the case, the pain felt by multinationals (via reduced profit outlooks) is only beginning (even as the Fed enters a tightening cycle).

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.